Question

Martin Shipping Lines issued bonds ten years ago at $5,900 per bond. The bonds had a 30-year life when issued, with semiannual payments at the then annual rate of 10 percent. This return was in line with required returns by bondholders at that point, as described below: |

Real rate of return | 2 | % |

Inflation premium | 4 | |

Risk premium | 4 | |

Total return | 10 | % |

Assume that today the inflation premium is only 2 percent and is appropriately reflected in the required return (or yield to maturity) of the bonds. |

Compute the new price of the bond. Use Appendix B and Appendix
D. |

Answer #1

Face Value = $5,900

Annual Coupon Rate = 10%

Semiannual Coupon Rate = 5%

Semiannual Coupon = 5% * $5,900

Semiannual Coupon = $295

Time to Maturity = 20 years

Semiannual Period to Maturity = 40

Annual Return = Real Rate of Return + Inflation Premium + Risk
Premium

Annual Return = 2% + 2% + 4%

Annual Return = 8%

Semiannual Return = 4%

Price of Bond = $295 * PVA of $1 (4%, 40) + $5,900 * PV of $1
(4%, 40)

Price of Bond = $295 * 19.7928 + $5,900 * 0.2083

Price of Bond = $7,067.85

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